Financial markets

Monetary policy

The next step

THE idea that central banks might cancel their government debt holdings, or restructure them into zero coupon debt, is gaining traction. A speech by Adair Turner, a candidate to be governor of the Bank of England, was reported as alluding to the idea last week (although it certainly wasn't mentioned explicitly). Gavyn Davies, the former Goldman Sachs economist, discusses the possibility in his blog.

It certainly seems the logical endpoint of the policy. In several previous posts, I have suggested that it is difficult to imagine how central banks will offload the bond piles they have accumulated. (There is no practical difference between selling the bonds and not reinvesting the proceeds when they mature; the private sector will have to absorb the bank's unwanted bonds plus whatever new supply the government is issuing that year. As there is no immediate prospect of governments eliminating their deficits, that would likely lead to indigestion in the markets and a big jump in yields. The central banks are unlikely to want yields to rise sharply any time soon. After all, the Fed has indicated it wants to keep short rates low until 2015.)

So central banks are likely to be the biggest single holders of government bonds for a while. And to the layman this looks rather absurd. The government is paying interest to a body that is an arm of itself, rather like a husband paying interest to his wife. It would surely be simpler to write the whole lot off. David Owen of Jefferies suggests how central banks will be able to find an economic justification.

The existing rationale for QE would simply be adjusted to say that unless debt service costs go to zero, there is a risk of inflation undershooting the target because the economy is simply too weighed down by debt. Is this plausible? Clearly we are in already in uncharted waters in terms of monetary policy, but the point which is being made is that whatever policymakers have been throwing at the economy up until now has not worked. Which means that the alchemy of central banks monetising debt should perhaps not be dismissed as such a far-fetched idea after all.

Of course, this is not what the central banks say they are going to do. They have been very careful to buy bonds in the secondary market, rather than direct from the government. The latter step would be the dreaded debt monetisation practiced by Reichsbank president Rudolf von Havenstein. As Gavyn Davies points out, even Paul Krugman, an enthusiast for unorthodox monetary policy, finds the prospect alarming.

Again a long-running theme of this blog is that developed world debt (and by this I mean the aggregate number including private sector debt and public liabilities that are not on the balance sheet like pensions and healthcare) cannot be repaid and thus there will have to be either defaults or inflation. Some people think that inflation is the least worst option and they may be right, although history teaches us that hyperinflation brings chaos in its wake.

But I also have practical doubts about the zero coupon conversion option. Central banks don't own just one tranche of government debt; they are invested across a range of maturities. Conversion would mean two classes of all these bonds; those earning zero at the central bank (and having a long maturity), and those paying interest elsewhere. Can that be done without the rating agencies declaring a default? It's not clear. The Greek episode suggested that the rating agencies cared about whether the conversion was voluntary or not and the central bank would clearly be volunteering. But non-payment of interest is technically a default.

There is also a signalling problem. Even if the markets could be persuaded that the cancellation or conversion of part of the debt was not the prelude to monetary armageddon, what will the effect be on elected politicians? They will have been given access to the printing press, confident that their deficits will always be financed by a willing buyer.

It is easy to understand why central banks have done what they have done so far; they want to avoid another great depression. Nevertheless, the nagging feeling remains; if zero interest rates and unlimited deficits were the answer to our economic problems, you think we would have worked it out before now.

I am afraid this discussion is pointless. Central banks writing off its government's debt would equal printing money. But since central banks already are buying their government's debt - and buying its government's debt essentially means that the state is buying its own debt - the printing has already been done. Whether the debt is bought second hand or directly from the government makes no difference. It is Reichsbank debt monetisation all the same. And, whatever the damage will be, as I said, it has already been done.

I use the term "fictitious capital" to describe what the Big Bankers, public and private, are attempting to inflict on the ordinary 99% people who through their entrepreneur led labour create ALL REAL value, capital included.
In the middle of the 19th century Karl Marx coined this term to describe the notes and loans that governments and gentry used to finance wars, luxuries, estates and otherwise living beyond their REAL means.
At that time such paper would accrue during "Boom" times as the economy expanded and would usually max out at around 10-12% of a countries GDP. As long as the good times rolled on it was not a problem, but came a crisis of over production (of all the wrong things) there would be the day of reckoning. Ergo, the bill collectors came and cash not paper promises was the order of the day. This resulted in a variety of ways to settle; some were paid in part or in full but more often bankruptcies and swindles resulted. Then the stage was set for the next cycle - boom bust.
Today though the situation with 'fictitious' or 'counterfeit capital is vastly different.
100 years of pumped up growth for growths sake first based on the now discredited ideas of John Maynard Keynes has produced a situation where some 20 times the worlds gross product exists as fictitious capital, a counterfeit collection of deficits, bills, bonds, exchanges, derivatives, swaps and the latest fraud, "quantitive easing". (Le Monde Diplomatique puts it at 50 times)
Every day we read of new Central and private bank meetings, "Increasing capital base" is their current fad.
COD'S's WALLOP! There is not a farthing of REAL capital in all of this rat-bag of lies, swindles and manipulations.
REAL capital is ONLY accumulated labour dedicated to enhancing future production. Ergo entrepreneur led LABOUR (of the 99%) is the only source that can augment existing capital or create new.
The banksters, led by the IMF, USA FED, and British "financial services" are well aware of this fact but that will not stop them from attempting to download this fraud onto the REAL product of Labour in the form of "bailouts" of "sovereign" debts, to be serviced by taxes on the REAL producers.
The 99% will be robbed of (much prepaid) social services and benefits to service "debts". “Austerity” it is called when those who had NO hand in running up this fraud are required to pay interest that will amount to 40-60% of the future product of their labour. Gone will be pensions, good schools, decent medical care, infrastructure (e.g. utilities that work reliably); even adequate diets will be history.

"Let them eat cake!" exclaimed La Royale Marie Antoinette.
Let them eat garbage, implies La Grande Dame Christine LaGarde, of the International Monetary Fascists(IMF)
So Greece, you are the front line today, Italy and Spain may be next, but do not think that any country, including the relatively well off Germany or the resource rich Canada and Australia will be forever exempt. Ms Merkel, beware!
The "poor little ones" are but appetizers; they will whet the appetites of these financial service vultures and jackals. For certain if they succeed in the beginning the taste of financial carrion will make them hunger for more, and they will finish only when the 99% of humanity is subject as debtors to enslavement by the 1%.
But this does not have to be!
Greece you can repudiate the fraud! Lead the way! DEFAULT is the way to go!
99%; be inclusive! Support Greece today, Italy Spain, …, &c. tomorrow and.../?/ the world in future.
Hold on to your souls! Hang tough!
You have a WORLD to WIN

Printing is confiscation. Printers sit around in a room and debate how much of other people's stuff they will take this month. Printers take stuff regressively, which means that the vulnerable are selectively targeted by printers. For example, the elderly who lose their pensions to printing cannot replace them.

"Cancelling" the debt is unnecessary. If we used proper accounting, it is in effect already cancelled. Any fiscal solvency calculation should use net debt, so the assets of the Central Bank should be netted off the govt liabilities. The UK's net debt is therefore 40% or so lower than its gross debt (another reason why there is no solvency risk). The economic effect of cancelling the debt is therefore zero. As a practical matter, it makes sense to keep the debt, because if the central bank wants to reduce bank reserves in future it can sell its bond holdings back to the market; issuing new debt might require additional legal powers.

1) Printing is extremely counter productive. For example, note the disaster that followed banks printing the housing Minsky. As Keynes noted, printing "engages all the hidden forces of economic law on the side of destruction".

2) The financial sector is siphoning off a significant fraction of the loot confiscated by printing. Banks are confiscating vast loot, and using the loot to carry out radical experiments in bank central planning of the economy. Its not working. Financial sector players are getting rich by confiscating other people's stuff.

3) Printing has eradicated the middle class. A generation ago, one wage could support a family. Now it takes 2 jobs plus overtime. The median real wage has been going backward since the gold window was closed in 1971.

4) Printing is a bank tax on state/local government too. State and local budgets across the nation are near bankruptcy. Printing has confiscated purchasing power from revenue.

5) Social Security was never meant to be the sole income for the elderly. Unfortunately, printing is slowly eradicating corporate pensions, IRA savings, etc...

The balance sheet of a Central Bank does not mean anything, since it can print money at will. And there's no way a Central Bank can be bankrupt (at least not in the currency it prints).
The only asset a Central Bank needs is confidence from the public. So far, a fair amount of QE did nothing to damage this confidence (because balance sheet does not matter).

What politicians and economists are implicitly saying - perhaps with different nuances- boils down to this: "We can not understand the mess we have managed to create, so let us call time out and see what the next generation can do about it, hopefully one way or the other they will survive".

An alternative solution to Mr. Havenstein's inflationary way would be what his successors did, ending inflation and stabilizing the German currency after 1924: Don't monetize state debt, but monetize state assets, such as land. There is no a priori reason why a commodity (like gold) should be a better cover for a currency than other tangible and inflation-proof assets (like real estate).

Monetizing real estate would not be inflationary, since the currency would still be backed by real assets and not just government paper. It would also be a strong contribution to overcome the financial crisis, which was originally caused by collapsing land prices first in the US and later in some European countries. E.g. Spain was actually running a budget surplus before but finds itself in debt now after bailing out the banks - who became insolvent due to collapsing real estate prices.

So a possible mechanism would be for the Spanish banks to pass their mortgage holdings to the state treasury, who then can pass them on to the Central Bank, who in turn passes them to the ECB as security for their loans. The German public would certainly much prefer to own Spanish real estate rather than Spanish government paper!

In the US something similar could probably be done with troubled real estate assets, such as Fanny's and Freddy's.

In the US, interest received by the Fed in excess of that needed for operations is returned to the US Treasury. So, there is no reason to forgive the debt, as there is no real interest associated with the debt. Wall Street is also happy with the arrangement, as they get their commission on turning the debt back to the Fed, once when they buy from the Treasury, and once when they sell it to the Fed. Should the Fed decide to forgive the debt, to balance their books, they would have to not rebate interest to the treasury, and would end up buying as many bonds as if they didn't forgive debt.

"If we used proper accounting…" stop right there. Countries never use proper accounting.

The smoke and mirrors trick with the central bank being part of the government is referred to in the article. The problem with this assumption, or the degree to which this is assumed to be true is that government departments cannot be expected to act independently. To mix metaphors, this would like revealing the man behind the curtain and strip the central bank of credibility. It might still be able to print money but would have trouble in any currency trades.

"it [the central bank] can sell its bond holdings back to the market". This is exactly what Buttonwood is suggesting is going to be increasingly difficult to do. You cannot have it both ways: either the debt is real in which case it must either be paid or written off; or it has magically gone away in which case what was all the QE for?

Buttonwood has been consistently pointing out: the debt can be either written off, paid off directly or paid off by the poor through inflation.

When a central bank holds bonds of the government, the State owes money to itself and pays interest to itself.
If the Government is not able to pay the interests, nothing prevents the CB to print money, hand it to the Government, receive it as interest payment and cancel it. There are absolutely no budget or solvency implications.
The thing is that QE is an increase of the money base that comes with the implicit promise to be cancelled once the bonds come to maturity.
Because of that promise, QE has no impact on inflation expectations.
And as long as QE is conducted under a Zero-Lower-Bound context, it has no impact on current inflation.
So, the only problem with cancelling debt held by a Central Bank is the possible impact on inflation.
Yet, there are circumstances when a Central Bank may find desirable to increase inflation or inflation expectations. Then, the question is reduced to a matter of fine-tuning, in order to keep inflation under control.
(Note that there is a fundamental reason why a Central Bank may not be ready to cancel Government debts: as long as it holds enough Government bonds, it remains the arm of the State with the control over economic policy).

This sounds like an haircut to me. OK as long as the other banks get the same haircut. Greek, Portuguese and Irish banks have all had haircuts why not others? The banks caused the financial crisis by badly managed lending. Let the same banks take the loss resulting from their mistakes. I suggest a simple message to the banks, take a haircut or have an eventual meeting with Mrs Merkel such as the Spanish are anxiously seeking to avoid. The debt is paper so just loike knocking some zeros off when currencies get out of hand apply an haircut across the board. ECB might want to do this across the eurozone as well?

I dont see how it is possible to cancel the debt. The BoE has a huge liability to the commercial banks from which it bought the gilts in the first place. Cancelling the debt will make the BoE bankrupt.

It can't be done. Would be nice if someone who understood double entry book keeping could explain how to make debt disappear.

Fiat currency acquires value by making transactions easier, say, compared to barter.
In a slow economy with less transactions, the money automatically lose value; at zero transactions, value of currency is also zero and printing more of it will not move its value from zero.

Fiat currency can only have value as a form of stored energy. Think about the use of capital. In the vast majority of cases, currency is exchanged for some form of chemical, mechanical, or creative energy. Capital flows around the world to unleash productive and destructive forms of energy. Therefore the value of currency will eventually obey the laws of Thermodynamics. Defined as a form stored energy, the value of currency can be quantified. (jjoules of net productive energy / currency volume = value). I would appreciate comments or alternative ideas to describe the value of currency. desinc1@zoominternet.net.